About

Swap Spread

Interest Rate Swaps
October, 2007
Primary Analyst: Jason Stipanov
(212)-761-2983
jason.stipanov@morganstanley.comThe Primary Analyst(s) identified above certify that the views expressed in this report accurately reflect his/her/their personal views about the subject securities/instruments/issuers, and no part of his/her/their compensation was, is or will be directly or indirectly related to the specific views or recommendations contained herein. This report has been prepared in accordance with our conflict management policy. The policy describes our organizational and administrative arrangements for the avoidance, management and disclosure of conflicts of interest. The policy is available at www.morganstanley.com/institutional/research. Please see additional important disclosures at the end of this report.

Interest Rate Swaps
The Structure of a Swap

2

See additional important disclosures at the end of this report.

What is a Swap?
Spot-Starting 5-Year Fixed/Floating Swap ($100MM Notional)
Fixed Payments
Party A

Swap: Contractual agreement to exchange fixed for floating cash flows over a specified period of time

•

Floating rate reference: USD LIBOR

•

LIBOR: British Banker Association’s (BBA) fixing of the London Inter-Bank Offered Rate. A contributor bank contributes the rate at which it could borrow funds, if it were to do so by asking for and accepting inter-bank offers in reasonable market size just prior to 11 AM London time. 16 banks contribute, the top and bottom 4 fixings are eliminated, and the remaining 8 fixings are averaged. 3

See additional important disclosures at the end of this report.

A Cashflow Example
Swap rate = average of expected LIBOR settings
Suppose You Pay Fixed on a 2-year Swap at a Rate of 4.83%
Floating Leg

Fixed Leg

3M LIBOR = 5.21% (Quarterly, Actual/360)
3M LIBOR in 3 months

4.83% (Semi, 30/360)

3M LIBOR in 6 months
3M LIBOR in 9 months

4.83% (Semi, 30/360)

3M LIBOR in 1 year
3M LIBOR in 1YR 3M

4.83% (Semi, 30/360)

3M LIBOR in 1YR 6M
3M LIBOR in 1YR 9M

4

4.83% (Semi, 30/360)

See additional important disclosures at the end of this report.

A Swap is Similar to a Leveraged Bond
Similar to a leveraged bond transaction
Swap Transaction Is Similar to a Bond Transaction
Combined with 3-Month Financing
Receive Fixed on a Swap

You
Pay LIBOR

UST Rate (buy bonds)

You
Pay Repo

5

See additional important disclosures at the end of this report.

A Swap Is Different from a AA Bank Bond
An interest rate swap has different characteristics compared to a AA bank bond •

Differences between a swap contract and a AA bank bond
−
−
−

•

Swap: No risk of principal loss or default
Swap: Less risk of downgrade (if a bank is downgraded, it will be thrown out of the LIBOR panel)
Swap: Majority of trades are collateralized, thus reducing counterparty risk

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Discussion Questions
Due April 12, 2012
Please complete these questions in groups of 2, to hand in. The grade is calculated as part of your participation grade, so participation, as with the last case, can improve your score substantially, even if your calculations aren’t all perfect!
Should Albert Mills do this trade? Back up your answer with the following analyses:
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Introduction
FHSS
DSSS
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Conclusion
5
10
10
5
10
Using your textbook and web research, in your own words, summarize what you have learned about Spread Spectrum transmission.
Requirements: Minimum one paragraph per section; best practice is two or more paragraphs per section.
Total
50
A quality paper will meet or exceed all of the above requirements.
Deliverables
IMPORTANT: A report template is provided beginning on the next page, and you must use it to submit your assignment. Before submitting your assignment, delete the pages containing the instruction and rubric.
Your submitted assignment should begin with the Title Page and only contain your report. Don’t forget to place your name, your professor’s name, and the date on the Title Page.
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